Including 7 Ways To Make Your Dividend Income More Reliable
Today I will address an important question. Specifically, are dividends guaranteed on common stocks?
Furthermore, I will also provide several tips for anyone interested in earning a reliable dividend income stream.
Let’s get after it right now.
Are Dividends Guaranteed On Common Stocks?
No, companies are NOT legally required to pay dividends. Furthermore, businesses that currently choose to pay dividends may reduce, temporarily suspend, or terminate their dividend payments at any time and for any reason. Thus, a policy to reduce or pay no dividends indicates that management has other priorities for company cash flow.
On the other hand, there are good ways to increase your odds of earning a growing passive income stream from dividends.
That discussion comes next.
Disclosure: At no cost to you, I may get commissions for purchases made through links in this post.
7 Ways To Make Your Dividend Income More Reliable
So, we know dividends are not guaranteed. However, earning a steady, growing stream of dividends is still possible.
Here are seven tips to make dividends more reliable:
- Invest in businesses that increase their dividends
- Buy companies with rich histories of paying dividends
- Stay away from stocks with high dividend yields
- Choose companies with low dividend payout ratios
- Avoid companies with excessive debt
- Build a portfolio of 20-30 dividend-growth stocks
- Consider a diversified dividend ETF
I will go through each of these points to further your understanding. You can also learn much more with:
The Financial Freedom Investing Course from Simply Investing
1. Invest In Businesses That Increase Their Dividends
A company that routinely increases its dividend typically has a safer dividend. After all, management will only be able to increase the dividend rate per share if they have the cash to do so.
Thus, invest in Dividend Kings. They have increased their dividend payouts for at least 50 consecutive years.
Or invest in Dividend Aristocrats. These companies are part of the S&P 500 stock market index. They have raised their dividends continuously for at least 25 years.
But understand this about Kings and Aristocrats. They can reduce, suspend, or eliminate their dividend payments too.
Yes. It is a rare occurrence. But it happens. Thus, these companies’ dividends are not guaranteed.
2. Buy Companies With Rich Histories Of Paying Dividends
There are many other great companies with solid dividend payment track records. So, there is no need to limit yourself to investments in Dividend Aristocrats or Kings.
However, these stocks are a little more challenging to identify. So, unfortunately, you won’t find them neatly arranged on a reliable list of dividend growers.
Please allow me to provide an example of one such stock.
I am speaking about Paychex (PAYX) here. Paychex provides payroll processing and other services to small and mid-sized businesses.
The company started paying recurring quarterly cash dividends to shareholders in 1988. And typically, management increases the dividend each year.
However, the company paused dividend growth during the last two recessions. So, you won’t find Paychex on the Dividend Kings or Aristocrats lists.
However, the company’s dividend rate per share has grown dramatically since 1988. On average, management has increased it by about 10% per year. Sometimes more, sometimes less, and sometimes not at all.
3. Stay Away From Stocks With High Dividend Yields
What is a high dividend yield? Well, the answer is it depends.
However, a high dividend yield is anything greater than 5%. At least for this conversation.
The next question is, why does a stock have a high dividend yield?
Answer: The dividend yield is inversely related to a stock’s price. So, as a stock price falls, the dividend yield increases.
Stock prices decline for many reasons. One reason is that investors feel the company has poor economic prospects and the stock is risky. Therefore, investors will buy or hold only at a lower price.
Thus, all else being equal, a company with poor prospects has a declining stock price. Furthermore, a lower price makes for higher dividend yields that indicate investment risk.
Therefore, chances increase that the dividend may be reduced, suspended, or eliminated.
As a result, are companies required to pay dividends? Absolutely not.
But you can increase your odds when investing in dividend stocks by understanding this next point.
4. Choose Companies With Low Dividend Payout Ratios
The dividend payout ratio (DPR) indicates how much of a company’s financial resources it pays out in dividends. However, interpreting dividend payout ratios can get complicated.
However, allow me to draw a simple conclusion for you.
The lower the dividend payout ratio, the better. It indicates the company can continue to pay its dividends even if it temporarily encounters difficult economic times.
However, a low dividend payout ratio does not guarantee your future dividends. It does, however, increase the odds your dividend payments will continue reliably into the future.
Finally, calculate the dividend payout ratio in several ways. To do so, use dividends as a percentage of accounting earnings, cash flow, or funds from operations for real estate investment trusts.
5. Avoid Companies With Excessive Debt
Unlike dividends, companies are legally required to make agreed-upon debt payments. Also, they must pay interest on that debt.
Thus, companies with high debt will reduce, suspend, or eliminate their dividends if necessary to meet their debt obligations.
As a result, the more debt a company has, the greater likelihood of a future reduction to your stock dividend earnings.
Okay. Let’s switch gears.
So far, we have discussed ensuring a reliable stream of dividends from one stock. However, we can take it one step further.
6. Build A Portfolio Of 20-30 Dividend-Growth Stocks
I encourage you to get your dividend income from a portfolio of 30 dividend-growth stocks, not from one stock. But, of course, as few as 20 may do.
Thus, own a diversified portfolio of stocks with a history of paying higher dividends yearly. Even if one company cuts or terminates its payout, the income from your portfolio will grow long-term.
7. Consider A Diversified Dividend ETF
Only some investors care to buy and maintain a portfolio of dividend stocks. If you are that person, consider a dividend-paying exchange-traded fund (ETF).
Many excellent ETFs pay dividends. Choose a good one and receive a consistent payout every year.
For example, I’ve owned the Vanguard High Dividend Yield (VYM) ETF for many years. Never once during that time have I failed to receive a quarterly dividend. And over the long run, the dividend rate per share has increased.
Of course, past performance is not indicative of future results. However, from my perspective as a shareholder of VYM, future dividends are guaranteed for the most part!
On the other hand, do companies have to pay dividends? You know by now the answer is no. So next, allow me to wrap up with a few parting thoughts.
Paying Dividends Is Not A Legal Obligation: Wrap Up
Now you know dividends are not guaranteed.
And yes, you can lose money on stocks that pay dividends. Unfortunately, investing in almost anything comes with the risk of loss.
However, there are effective ways to increase the odds of earning a growing stream of passive income from dividends.
To do so, first look for stocks with attractive long-term dividend histories and low debt. Then, stay away from high dividend yields and high dividend payout ratios.
Finally, own a diversified portfolio of dividend payers. You can do that by building a do-it-yourself dividend portfolio. Or by investing in a mutual fund that pays dividends.
Are you hungry for more knowledge? If yes, check out my archives of
Helpful Dividend Investing Tips and Articles
Author Bio: Tom Scott founded the consulting and coaching firm Dividends Diversify, LLC. He leverages his expertise and decades of experience in goal setting, relocation assistance, and investing for long-term wealth to help clients reach their full potential.